Economics 340H � WI 07 - PTBO Assignment #2

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```					                                DEPARTMENT OF ECONOMICS

Economics 340H – WI 07 - PTBO                              Assignment #2

Instructor: Christopher Michael                            Due Date: Nov 15, 2007

Question 1 – Production Theory

Communications Consultant Services, Inc., advises small to medium-sized businesses on
telephone equipment and network configurations. The primary resources CCS employs are skilled
network consultants and computers. Currently, CCS employs 16 consultants at a cost of \$70 per
hour (wage plus fringes and variable overhead), and purchases 160 hours of computer time each
week at a time-sharing cost of \$280 per hour. Each consultant works a 40-hour week. This level
of employment allows CCS to complete 213 communications analyses per week for which the
firm receives \$300 each.

a.    Assuming that both returns to factors and returns to scale are constant, what are the marginal
products for: (1) communication consultants and, (2) computer time (up to the full capacity
level)?

b.    Is CCS employing labor and computers in an optimal ratio, assuming that substitution of the
resources is possible? Explain.

c.    Determine the marginal revenue products for consultants and for the computer services
employed by CCS. (Assume constant returns to factors in part A.)

d.    Is CCS employing an optimal (profit-maximizing) quantity of labor and computer time?
Explain.

Question 2 – Production Theory

An industry can be characterized by the following production function:

Q  2.5L0.60 C 0.40

(a)   What is the algebraic expression for the marginal productivity of labour?
(b)   What is the algebraic expression for the average productivity of labour?
(c)   What is the elasticity of production with respect to labour?
(d)   Give an economic interpretation to the value determined in part (c).
(e)   How would you characterize the returns-to-scale in the industry?
Question 3 – Cost Volume Profit Analysis and Operating Leverage (Hint use Web appendix
to chapter 5).

a)   What is the formula used to show the breakeven output for a firm?
b)   What is the formula used to determine a firm’s target output?
c)   What is the formula used to determine a firm’s degree of operating leverage?
d)   Why are executives interested in a firm’s degree of operating leverage?
e)   Now suppose two firms in the same industry sell their product at P=20 per unit, but in
one firm the total fixed cost is \$40 and average variable cost is \$10. In the other firm the
total fixed cost is \$90 and average variable cost is \$9. Determine the breakeven output of
each firm. Why is the break even output larger for the second firm? Find the degree of
operating leverage of each firm at Q=7 and Q=8? Why is the degree of operating leverage
greater at Q=7 vs Q=8?

Question 4 – Price and Output Determination

The Sleep Company believes that its industry can best be classified as monopolistic competitive.
An analysis of the demand for its canopy bed has resulted in the following demand function:

P = 1,760 – 12Q

The cost department has estimated the total cost function:

1
TC  Q 3  15Q 2  5Q  24000
3

a)   Calculate the level of output that should be produced to maximize short run profits.
b)   What price should be charged?
c)   Compute total profits at the price – output level.
d)   Compute the point price elasticity of demand at the profit maximizing level of output.
e)   What level of fixed costs is the firm experiencing in bed production?
f)   What is the impact of a \$5,000 increase in the level of fixed cost on the price charged,
output produced and profit generated?

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